Today’s low interest rates are exciting, and many homeowners are thinking about refinancing their mortgage loans. There’s a sort of FOMO (Fear of Missing Out) in the rush to get loans. But for those who already have fairly low, fixed interest rates (say, 5% or under), saving money through refinancing can cost more than it’s worth.
The question: Given the costs of refinancing, will a reduced interest rate prove worthwhile? The answer: It all depends. Let’s take a look some pros and cons of refinancing now.
No Free Lunch
Consider the costs. There’s a fee to apply for a new mortgage, and there are fees to process the loan. Even those “no-fee” refinance deals have fees, although they are rolled into the loan, so the customer pays them later. Tack on a few hundred dollars for professional services: a property assessment, a new title policy based on a new appraisal, notary services…
In short, refinancing isn’t free.
Once your mortgage broker estimates those total closing costs, the question becomes just how many months it will take to you to recoup them through your interest rate reduction. That’s when savings start — at the all-important break-even point. Divide the closing costs by your monthly interest savings to know roughly how many months it will take to break even. If it will be a long haul until the new loan pays for itself, or if you are in the later stages of your current mortgage, you might decide today isn’t the day to get a new loan.
Moreover, if you refinance, you could lower your rate but reset the timer, and end up paying interest for longer. Long-term savings could be insignificant — or nonexistent. If so, a better plan might be to keep the existing loan, and pay down the principal faster to save on interest payments.
Special Circumstances
Case-specific circumstances can make getting a new loan more urgent. Each of these six common situations (or a combination of them) can create compelling circumstances for mortgage refinancing in today’s low-interest environment:
- Scenario 1. The borrower’s current loan has private mortgage insurance tacked on, and refinancing is the best way out of that extra payment. This is often the case with FHA loans, as a full refinancing is the only way to shake off PMI, no matter how much equity the owner builds over time. For further information about PMI, see our guide to Private Mortgage Insurance here.
- Scenario 2. Current rates are low enough to effectively reduce or consolidate a home equity line. This may be the perfect time for some homeowners to explore whether it’s possible to consolidate higher-interest debt into a low-interest loan.
- Scenario 3. The borrower has to avert a mortgage default. Refinancing makes sense if obtaining a reduced monthly payment is a plausible, effective way — although refinancing for lower payments typically pushes the payoff date and mortgage release further into the future.
- Scenario 4. The borrower has access to government benefits — for example, by refinancing through the VA. Homeowners who have used VA loans to purchase their homes may tap into their remaining entitlements to refinance those homes.
- Scenario 5. A co-borrower agreed to be on the title to enable the primary borrower to buy the house. Now, the primary borrower is ready to refinance the loan, and take on the title as sole owner.
- Scenario 6. The borrower works for a firm, or is a member of a credit union, which is offering a special members’ rate. It’s often worth calling the local credit union offices and the smaller banks. In some cases, can offer lower costs and more personalized attention than the big banks.
Aspiring borrowers can apply with online lenders, too, to broaden the selection of loan estimates. Just keep in mind that companies often advertise rates to draw potential customers in, but those teasers could be adjustable rates, or they could include points. And depending on your personal credit profile and current home equity, your rate can differ substantially from publicly advertised quotes.
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Comparing Refinancing Offers
Each lender will offer a prospective borrower a unique set of interest rates, refinancing timelines, and closing costs. How does a borrower tap into the information necessary to compare available loans? The key is to request written loan estimates to make effective comparisons among several lenders. Obtaining written loan estimates is free.
Yes, lenders do credit checks each time they’re asked to provide a quote. But according to the U.S. Consumer Financial Protection Bureau, you may request as many mortgage quotes as you wish within a 45-day period. Your credit score will not suffer multiple inquiries. This is because the credit companies understand that you are likely to choose only one loan, no matter how many home loan quotes you request.
Your current lender could come through for you when other proposals fall short of the mark. Your lender might offer you a discount, a reissue, or a loan modification — all methods of getting better terms with fewer papers and fees. And if you get a great quote from another lender, tell your current lender. Lenders like to keep good customers. Sometimes they’re willing to match another proposal to do so.
Other perks your current lender might offer include rolling over your current escrow account, and even keeping your amortization schedule rather than resetting your length of time to payoff. Your current lender might be able to avoid certain third-party services and fees. Each lender has different options beyond simply quoting new rates. It never hurts to find out how yours can work with you.
Finally, when you commit to a loan, expect your interest rate to fluctuate between the initial quote to the closing date. Depending on the lender, it may or may not be possible to benefit from substantial drops in interest rates during that window.
Fine print: When refinancing with a current lender, the borrower gives up the right of rescission — an allowance for backing out of the new terms and getting a refund within three days after closing. A refinancing or consolidation by the same creditor, says the law, does not allow for the right. Yet the right of rescission is still good for any part of the new amount that “exceeds the unpaid principal balance, any earned unpaid finance charge on the existing debt, and amounts attributed solely to the costs of the refinancing or consolidation.”
Beyond the Market Buzz
If you’re like most homeowners, you’re wondering which lenders are most likely to offer the fairest and best terms to fit your situation. Because each home and homeowner is unique, the best way to find out is to shop around. That doesn’t mean going it alone. You can start with your tried-and-true mortgage broker, and ask for options along with professional advice tailored to your finances. Your expert can draw up a mortgage amortization chart, and tell you if your savings over the course of a given loan will substantially offset the costs.
The main thing is to treat a new loan as a product. If you buy it, will you really be better off?
And that brings us to our key takeaway on refinancing. Each homeowner’s situation, not the market and its buzz, is what really matters when you’re deciding whether or not to refinance a mortgage.
Supporting References
12 C.F.R. § 226.23(f)(2).
Photo credit: Bruce Mars, via Unsplash.